FedEx (FDX) CEO Frederick W. Smith said he expects up to 30% of long-distance trucks to be powered by liquified (LNG) or compressed natural gas (CNG) over the next 10 years. 

While there is ample research to show that the use of natural gas in transportation can reduce carbon emissions significantly, the high costs associated with these vehicles and relative scarcity of fueling stations have hindered their adoption up to now.

Here, we take a look at the key factors expected to drive adoption rates of CNG/LNG vehicles in the transportation industry over our forecast period. This trend is expected to improve EBITDA margins for the FedEx Ground segment, which makes up more than 67% of Trefis' current price estimate for the stock. 

Natural gas supply and prices

The rise in domestic supply of natural gas since the advent of hydraulic fracturing technology has been one of the biggest factors driving increased adoption rates of this source of energy. Even as demand for natural gas has been increasing at a rapid pace driven by higher adoption in electricity generation, faster growth in its production from shale gas reserves has kept prices in check. While the average diesel price is above $4 per gallon, the same amount of CNG (gallon gasoline equivalent) can be bought for almost half the price in the U.S. The efficiency of a machine in converting either of these fuels into power is also an important factor and does partially offset the price advantage of CNG over gasoline in some cases. This particular Freightliner (see YouTube) has around 10% lower fuel efficiency with CNG as compared to diesel and still provides operational gains over the traditional fuel.

Less environmental impact

Natural gas vehicles offer a significant opportunity to reduce green house gases (GHG) emissions as compared to gasoline powered vehicles. According to the Center for Climate and Energy Solutions, the use of LNG and CNG as alternatives to diesel can reduce carbon intensity (the amount of carbon by weight emitted per unit of energy consumed) measured in gCO2e/MJ by 13% and 29% respectively. The same study suggests that reductions of conventional air pollutants from natural gas vehicles are also significant.

According to the report:

A 2001 study conducted by the Department of Energy's National Renewable Energy Laboratory (NREL) found that natural gas vehicles in the United Parcel Service CNG fleet emitted 95% less particulate matter, 75% less carbon monoxide, 49% less nitrogen oxides and 7% less volatile organic compounds than their diesel-powered equivalents.

Fueling infrastructure

The absence of a robust fueling infrastructure for CNG has been the most prominent factor dampening the rate of adoption of natural gas fuel variants in transportation. Including both public and private, the total number of CNG fueling stations in the U.S. stands at 1,197, according to the Department of Energy. This compares to about 180,000 gasoline stations. However, we expect to see this number to improve over the forecast period driven by higher demand for CNG vehicles due to lower operational costs and government (both federal and state) laws and incentives to boost growth in alternative fueling infrastructure.

Vehicle cost and range

High initial costs of LNG/CNG vehicles as compared to gasoline alternatives have also negatively impacted their demand. Currently, LNG powered tractor-trailer trucks cost around $75,000 more than the ones that run on diesel. Increasing mass production and competitive forces are expected to drive this premium down in the long run as these products gain wider acceptance.

Another factor hindering the adoption rate is the lower energy density of natural gas fuel variants compared to diesel which causes fuel tanks in these vehicles to be larger than those required for gasoline. This factor is responsible for restricting the range of natural gas powered consumer vehicles as any incremental space used for fuel reduces passenger utility.

Overall, we feel even though there are enough economic and environmental factors driving higher demand for natural gas as a source of energy to the transportation industry, its growth rate will be limited by the rate at which the fueling infrastructure grows and the relative affordability of these vehicles.

We currently forecast the FedEx Ground segment EBITDA margins to increase to around 30% in the long run driven by the company's cost-cutting measures. However, the higher-than-estimate​d rate of adoption of CNG and LNG vehicles can significantly lower operating costs of the company's ground operations and could imply potential upside to the Trefis $122 price estimate.